Price Breakout Strategy
Breakout trading means entering a violent trend in its early stages. The aim of this strategy is to take advantage of a major price move, and to trade it by being exposed to limited downside risk.
What is a Breakout?
A breakout means that the price of an asset starts to moves outside a defined price level. This price level may be a support or resistance level, a channel, a trend line, a Fibonacci level, a pivot point and etc. Breakouts are important because as they are followed by strong price swings.
But be aware that most of the times, breakouts are false. However, there are times when breakouts are real and then your positions can be really profitable.
Types of Price Breakouts
Price breakouts, in general, are divided in continuation and reversal breakouts:
(i) Continuation breakouts
(ii) Reversal breakouts
In the case of a continuation breakout, the price of an asset breaks an established price level (usually previous high) and continues to trend. The goal is to take your profit near the next local high. The longer the accumulation of prices before the breakout the stronger the breakout shall be.
The goal of trading reversal breakouts is to spot the last stage of an existing trend. The end of a trend usually occurs when the price has reached overbought levels or it has been stopped by an important support or resistance level. The aim for breakout traders is to get in at the early stages of this new trend. The reversal breakout trading is very difficult to prove profitable for inexperienced traders. The vast majority of reversal signals prove false.
The problem of lack of volume data
Stock traders know well that when you are trading stocks, breakouts must be accompanied by significantly increased volume. The problem in the Forex market is that traders do not have access to aggregate volume data. This is a disadvantage for Forex breakout traders.
False Breakouts and Conspiracy Theories
In general, a false breakout occurs when the price of an asset crosses through a major support or resistance level, but then the price suddenly retreats back.
There are many theories that Institutional Players (large investment Banks) are behind these false breakouts in order to push their clients to their stop-loss orders and make easy money. In any case, a false breakout means that the market does not respond as traders have anticipated.
Techniques for Avoiding False Breakouts
There are many ways to avoid false breakouts and to filter your trades. The disadvantage of filtering your trades is that you shall get in later than other breakout traders. The advantage is that will avoid at least 60% of all the false breakouts.
Here are some tips to avoid False Breakouts:
BEFORE THE BREAKOUT OCCURS
(1) Seek for Volatility. Volatile markets provide much more reliable breakouts. You can use ATR indicator on MT4 (Average True Range) or you can use an online tool seeking for high recent volatility:
(2) Check for potential price patterns or price formations that may be formed.
(3) Confirm the new price momentum using a momentum indicator (i.e. MACD)
(4) Seek for divergences between MACD or RSI charts and the Real Price Action. (This tactic can be particularly useful in order to confirm reversal breakouts).
(5) Check the charts of correlated Forex pairs. For example, if you want to trade an EURUSD breakout check the USD Index and GBPUSD charts.
(6) Do not trade price breakouts in late hours they will probably prove false. Prefer trading breakouts during session overlaps when market volume and volatility tops.
(7) Make sure that no important News Releases will disturb your breakout trade.
AFTERTHE BREAKOUT OCCURS
(1) Confirm the breakout in the H1 chart. That means ensuring that the price will close beyond the breakout level on the H1 chart.
(2) Place an order that will be activated only if the price exceeds 10 pips above the breakout level. Given that the Risk/Reward ratio will remain above 2.
■ Trading Price Breakouts